Principles of Microeconomics

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# Chapter 1: Introduction to Economics

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## What is microeconomics?

### Definitions
**Definition 1:** a collection of models of human behavior in society

**Definition 2:** the study of mankind's unlimited desires given society's limited resources

### Typical econ questions for this class
- How are the prices of goods and services determined?
- Why do firms engage in international trade, and how do government policies, such as tariffs, affect international trade?
- Why does government control the prices of some goods and services, and what are the effects of those controls?

### Consensus
- Do economists agree on the answers?

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## Three key economic ideas
.panelset.sideways[
.panel[.panel-name[Rationality]
### 1. People are rational

- Intentional behavior using all available information
  
  - Not random/thoughtless
  
  - Best decision given costs/benefits
  
  - Not automatons
  
]

- What are **incentives**?
  
  - Positive/negative incentives (e.g. carrot and stick)
  
  - Prices
    - "People respond to prices"
    - Prices serve as an incentive
    - This concept will become clearer
    
  - Example: Convicted felons required to submit DNA samples
]

- **Marginal analysis**
    - We don't mean this isn't important--it is
    - Most decisions involve doing a little more or a little less of something
    - So what happens if we add one additional action/unit?
      - Marginal cost 
      - Marginal benefit
  
  - **Optimal**
    - Given some goal(s) and constraint(s), there will exist a *best* set of choices
    - Compare marginal cost vs. marginal benefit
    - When these are the same, that is the optimal choice
  
  - Example
    - Should you watch an extra hour of TV or study instead?

]
]
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## The fundamental problem

**Scarcity** implies trade-offs

**Trade-offs** - producing more of one good or service means producing less of another good or service

*Paul Samuelson* said every society must answer these questions:
  1. What are you going to produce?
  2. How are you going to produce it?
  3. To whom will you distribute the things you made?
  
**Opportunity cost** - the highest valued alternative that must be sacrificed to engage in an activity
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.pull-right[
<img src="data:image/png;base64,#images/tradeoffs.png" width="100%" />
]
]

.panel[.panel-name[What]
### What goods and services will be produced?
.pull-left[
- Who decides what is produced?

- Why can't we produce whatever/however much we want?

- Example: The opportunity cost of increased funding for space exploration might be giving up the opportunity to fund cancer research
]
.pull-right[
<img src="data:image/png;base64,#images/opp_cost.jpeg" width="100%" />
]
]

.panel[.panel-name[How]
### How will the goods and services be produced?
  
  - Handmade vs. machine-made
  
  - 1 really good person vs. a couple of ok people
  
  - Domestic vs. foreign (e.g. outsourcing)
  
  - Example #1: A music producer can make a song sound good by:
    - Hiring a great singer and using standard production techniques.
    - Hiring a mediocre singer and using Auto-Tune to correct the inaccuracies.

- Example #2: As the cost of manufacturing labor changes, a firm might respond by:
    - Changing its production technique to one that employs more machines and fewer workers.
    - Moving its factory to a location with cheaper labor.

]

.panel[.panel-name[Who]
### Who will receive the goods and services produced?
  - How is the U.S. currently set up to decide who gets goods/services?
  
  
  - Why might this be good/bad?
  
  - How do we address this in the U.S.?
  


]
]

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## Solutions
.panelset.sideways[
.panel[.panel-name[Types of Economies]
  - **Centrally planned economy**: An economy in which the government decides how economic resources will be allocated.
  
  - **Market economy**: An economy in which the decisions of households and firms interacting in markets allocate economic resources.

- **Mixed economy**: An economy in which most economic decisions result from the interaction of buyers and sellers in markets but in which the government plays a significant role in the allocation of resources.

- Which of these best describes the United States today?
]

.panel[.panel-name[Efficiency]
  - Market economies tend to be more efficient than centrally-planned economies.
  
  - Market economies promote:
    - **Productive efficiency** - a situation in which a good or service is produced at the lowest possible cost
    - **Allocative efficiency** 
      - A state of the economy in which production is in accordance with consumer preferences
      - Every good or service is produced up to the point where the last unit provides a marginal benefit to society equal to the marginal cost of producing it

]

.panel[.panel-name[Sources]
  - Productive efficiency comes about because of competition
  
  - Allocative efficiency arises due to voluntary exchange
  
  - **Voluntary exchange**: 
    - A situation that occurs in markets when both the buyer and the seller of a product are made better off by the transaction
    - Each transaction that takes place improves the well-being of the buyer and seller
    - Transactions continue until no further improvement can take place

- MB = MC
  
  
    
    
]

.panel[.panel-name[Caveats]
  
  - Markets may not result in fully efficient outcomes
  
  - People might not immediately do things in the most efficient way
  
  - Governments might interfere with market outcomes
  
  - Market outcomes might ignore the desires of people who are not involved in transactions – ex: pollution

]

- Less efficient outcomes may be more fair or equitable

- **Equity**
    - The fair distribution of economic benefits
    - An important trade-off for a government is that between efficiency and equity

- Example
    - If we tax income, people might work less or open fewer businesses, but those tax receipts can fund programs that aid the poor

]
]

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## Economic models
.panelset.sideways[
.panel[.panel-name[Overview]
### What are economic models?
  - Models are used to answer questions
    - "What effect does immigration of technical workers have on the US economy?"
    - "How does a hospital acquiring a physician shift the physician's incentives? Does it cost more for patients?"

- Building an economic model often follows these steps:
    1. Decide on the assumptions to use
    2. Formulate a testable hypothesis
    3. Use economic data to test the hypothesis
    4. Revise the model if it fails to explain the economic data well
    5. Retain the revised model to help answer similar economic questions in the future
]

.panel[.panel-name[Assumptions]
### The role of assumptions
  - The world is complex, we need to make the problem tractable

- The trade-off: 
    - Make enough simplifications to be able to work the problem 
    - Balance how close to reality the model is

- Behavioral assumptions
    - Consumers will buy goods and services to maximize their well-being.
    - Firms act to maximize their profits.

- Are these assumptions correct?
    - It depends
    - So we test...
]

.panel[.panel-name[Questions]
### Forming hypotheses in economic models
  - **Hypothesis** - a statement about an economic variable that may be either correct or incorrect
  
  - **Economic variables** - something measurable that can have different values, such as the number of people employed in manufacturing
  
  - Examples
    - Immigration of technical workers reduces wages paid to software programmers in the United States
      - Theory based
      - Predicts causal relationship
      - Can use data to test
      
        
        
        
    - The increased use of industrial robots and information technology in U.S. factories has resulted in a decline in manufacturing employment
  
  - Most economic hypotheses are about *causal relationships*

]

.panel[.panel-name[Answers]
### Testing hypotheses in economic models
  - After collecting the relevant data, economists use statistical methods to evaluate the hypotheses

- Correlation vs. causation
    - It is often difficult to establish whether an effect is causal
    - Examples: 
      - Employment in manufacturing did decline at the same time that the use of robots increased, but that doesn’t prove one caused the other
      - [Spurious correlations](https://www.tylervigen.com/spurious-correlations)

- Economists accept and use an economic model if it leads to hypotheses that are not rejected by statistical analysis
  
  - New information may reject previously believed hypotheses.
]

.panel[.panel-name[Positive vs. Normative]
### Positive and normative analysis

- **Positive analysis**
    - Analysis concerned with what is
    - An increase in the minimum wage to $15 per hour will reduce employment among low skilled workers
    - Not saying that this is a good or bad thing, but a statement about what is or what will happen

- **Normative analysis** 
    - Analysis concerned with what should be
    - We should increase the minimum wage to $15 per hour to increase the earnings of low skilled workers
    - This is an ethical statement
  
  - *Economists mostly perform positive analysis*
]

.panel[.panel-name[Micro vs. Macro]
### What's the difference between micro and macroeconomics
  - **Microeconomics** is the study of:
    - how households and firms make choices
    - how they interact in markets
    - how the government attempts to influence their choices

- **Macroeconomics**
    - is the study of the economy as a whole
    - includes topics such as inflation, unemployment, and economic growth
]
]

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## Quick Review

- The fundamental problem
  1.	What are you going to produce?
  2.	How are you going to produce it?
  3.	To whom will you distribute the things you made?

- How do we solve this problem
	- Economy structure: market vs. centrally planned
	- Productive/allocative efficiency
	- Resource vs. knowledge allocation

- Positive vs. Normative

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# Math Review

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## Using graphs and formulas
.panelset[
.panel[.panel-name[Bar graph]
<img src="data:image/png;base64,#ch_1_files/figure-html/unnamed-chunk-5-1.png" width="100%" />

]

.panel[.panel-name[Two Variables]
.pull-left[
  - Two-dimensional grid 
    - Price of pizza along the vertical axis (or y-axis) 
    - Quantity of pizza sold per week along the horizontal axis (or x-axis)
  
  - Each point represents one price/quantity combination from table
  
  - Line better illustrates the relationship; shows the slope

]
.pull-right[![](data:image/png;base64,#images/fig_1a3.png)]
]

.panel[.panel-name[Calculating Slope]
### Slope = "rise over run'
.pull-left[
  
$$
`\begin{aligned}
Slope &= \frac{\text{change in value on vertical axis}}{\text{change in value on horizontal axis}} \newline
&= \frac{\Delta y}{\Delta x} = \frac{\text{rise}}{\text{run}}\newline
&= \frac{\text{change in price}}{\text{change in quantity}} \newline
&= \frac{\Delta P}{\Delta Q} = \frac{\$12-\$14}{65-55} = \frac{-2}{10} = -0.2
\end{aligned}`
$$

]
.pull-right[![](data:image/png;base64,#images/fig_1a4.png)]
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- Relationship between quantity demanded of pizzas and price of pizzas

- *ceteris paribus* 
  - "all else equal"
  - nothing other than price affects the willingness to buy

- Assume only two options: hamburger and pizza

- What happens if hamburgers:
  - cost more?
  - cost less?
]
.pull-right[![](data:image/png;base64,#images/fig_1a5a.png)]
]

- Relationship between quantity demanded of pizzas and price of pizzas

- *ceteris paribus* 
  - "all else equal"
  - nothing other than price affects the willingness to buy

- Assume only two options: hamburger and pizza

- What happens if hamburgers:
  - cost more?
  - cost less?

]
.pull-right[![](data:image/png;base64,#images/fig_1a5b.png)]
]
.panel[.panel-name[-]
.pull-left[
- Demand curve

- Relationship between quantity demanded of pizzas and price of pizzas

- *ceteris paribus* 
  - "all else equal"
  - nothing other than price affects the willingness to buy

- Assume only two options: hamburger and pizza

- What happens if hamburgers:
  - cost more?
  - cost less?

]
.pull-right[![](data:image/png;base64,#images/fig_1a5c.png)]
]
]

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## Using graphs and formulas

.panelset[
.panel[.panel-name[Correlation]
#### Determining cause and effect
.pull-left[
- Positive and negative relationships meaningful, but do not necessarily imply causality
  - Correlation does not mean causality
  - *post hoc ergo propter hoc* fallacy - "after this therefore because of this"
- How determine
  - Deduction 
  - Experimental evidence
]
.pull-right[![](data:image/png;base64,#images/fig_1a6.png)]
]

.panel[.panel-name[Problems]
#### Hazards in determining cause and effect
.pull-left[
- Panel A
  - Do fires in fireplaces cause leaves to fall?
  - What explains this relationship?

- Panel B
  - Do lawn mowers cause the grass to grow faster?
  - What explains this relationship?
]
.pull-right[![](data:image/png;base64,#images/fig_1a7.png)]
]

.panel[.panel-name[Non-linearities]
.pull-left[
<img src="data:image/png;base64,#images/fig_1a8a.png" width="70%" style="display: block; margin: auto;" />
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.pull-right[
<img src="data:image/png;base64,#images/fig_1a8b.png" width="70%" style="display: block; margin: auto;" />
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.panel[.panel-name[.]
<img src="data:image/png;base64,#images/deriv1.jpg" width="70%" style="display: block; margin: auto;" />
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.panel[.panel-name[.]
<img src="data:image/png;base64,#images/deriv2.jpg" width="70%" style="display: block; margin: auto;" />
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<img src="data:image/png;base64,#images/deriv3.jpg" width="70%" style="display: block; margin: auto;" />
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<img src="data:image/png;base64,#images/deriv4.jpg" width="70%" style="display: block; margin: auto;" />
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<img src="data:image/png;base64,#images/deriv6.jpg" width="70%" style="display: block; margin: auto;" />
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.panel[.panel-name[.]
<img src="data:image/png;base64,#images/deriv7.jpg" width="70%" style="display: block; margin: auto;" />
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.panel[.panel-name[.]
<img src="data:image/png;base64,#images/deriv8.jpg" width="70%" style="display: block; margin: auto;" />
]

$$
`\begin{aligned}
A_{rectangle} &= b*h \newline
&= 125,000 * \$2.00 = \$250,000
\end{aligned}`
$$

![](data:image/png;base64,#images/fig_1a9.png)
]
.pull-right[
`$$A_{triangle} = \frac{1}{2}*b*h$$`
![](data:image/png;base64,#images/fig_1a10.png)
]
]
]

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